CFA Level 1

Alternative Investments - Open and closed-end funds

A "closed-end fund" is also legally known as a "closed-end company". It is an investment company that sells a fixed number of shares at a one-time initial public offering. Shares are not continuously offered for sale; after the public offering, the shares typically can be bought and sold only on a formal exchange such as the New York Stock Exchange or the Nasdaq. Closed-end funds come in many varieties. The investment strategies, risk tolerance, return objectives and overall investment portfolios of closed-end funds vary across a broad spectrum. The investment portfolios are actively managed by investment advisers.

Once closed-end fund shares begin to trade, their prices are determined by supply and demand and not by net-asset value (NAV); therefore, the market price may be greater or less than the shares' NAV. Generally, a closed-end fund is not required to buy its shares back from investors upon request. However, some closed-end funds, commonly referred to as interval funds, offer to repurchase their shares at specified intervals.

One of the significant differences between closed-end funds and mutual funds is that closed-end funds are allowed to invest in a greater amount of "illiquid" securities. (By "illiquid" we mean securities that can't be sold within a reasonable period of time - usually seven days - at the approximate price used by the fund in determining NAV.)

Most mutual funds are open-end funds but closed-end funds are subject to similar SEC registration and regulation requirements, and are subject to numerous requirements imposed for the protection of investors. Closed-end funds are regulated under the Investment Company Act of 1940 and are also subject to the Securities Act of 1933 and the Securities Exchange Act of 1934.

Although less popular than their open-ended counterparts, these investment vehicles are worth a second look. For more on these types of funds, review the following article: Open Your Eyes To Closed-End Funds.

Open-End Fund
In simple terms, an open-end mutual fund is when a company aggregates money from many investors and invests the money in stocks, bonds, short-term money-market instruments or other securities. Investors purchase mutual fund shares directly from the fund itself at a price that is determined by the fund's per-share net asset value (NAV) plus any shareholder fees that the fund imposes at purchase (such as sales loads). Mutual fund shares are "redeemable": when the holder of the mutual fund shares wants to sell those shares, he or she sells them back to the fund (or to a broker acting for the fund) at their approximate NAV minus any fees the fund imposes at that time (such as deferred sales loads or redemption fees). Open-end fund shares cannot be bought or sold in secondary markets, such as the New York Stock Exchange or the Nasdaq.

In most cases, mutual funds sell their shares continually to investors. However, there are circumstances where the investment adviser may close the fund to new investors - usually when it's decided that the fund has become too large to manage effectively. Like closed-end funds, the investment portfolios of open-end mutual funds vary broadly across many investment styles, return objectives, investment strategies and risk tolerance.

The fees charged by mutual funds can significantly impact total return and should be carefully assessed by investors. All funds charge investors some level of management fees for operating the fund. Some also pass on their distribution and service costs, commonly referred to as "12b-1" fees. In addition, "load" funds impose a sales charge when the shares are purchased (front load) or sold (back load). To cater to a wide variety of investors, funds may create a number of different "classes" of shares, with each class having different fees and expenses. Finally, some funds calculate sales charges based on the investment amount with larger investments incurring smaller fees (or eliminating the fee altogether). These investment threshold levels, known as breakpoints, are important features for investors.



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